Why You Should Know the Difference Between Costing and Pricing

By Tim Williams

By Tim Williams

During the past 15 years or so, there has been a pricing revolution in business.  Most large successful companies are staffed with professional pricers – people who make their living by determining the value, and therefore the price, of their company’s products and services.

Here’s the way today’s professional pricers approach their work:

Customer > Value > Price > Cost > Product

Pricing professionals know that because value is subjective, the process must start with the customer, the arbiter of value.  Once they’ve answered that question, they can determine a price.  Knowing what price they can charge, the company then evaluates the costs involved.  If they determine they can keep their costs below the price, they produce the product.

Virtually every major manufacturer or service provider prices this way.  Toyota, for example, starts by determining the value of a new car model to the customer, then sets the price, then determines what they can afford to invest in terms of costs, then – and only then – produce the product.

Now look at how most professional service firms – like advertising agencies – approach pricing:

Product > Cost > Price > Value > Customer

Yes, it’s backwards, both literally and figuratively.  They look at the product or service to be delivered, add up the projected cost in terms of hours, and then add a mark-up for profit.  That determines the price.  The problem is none of this has anything to do with the value to the customer.  And look where the customer is in this process: dead last.

No relationship between cost and value

The fact that an assignment is expected to take 53 hours of agency time bears no relationship to the value to the client.  The 53 hours might result in a very ugly, very ineffective banner campaign.  Did the cost of the time translate into value for the client?  Not at all.

Similarly, imagine that the agency invests 30 minutes in developing a brilliant idea that requires little to no production time (like buying some key words on Google) that earns the client tremendous success in the marketplace.  Again, was the cost of time equal to the value for the client?

Economists teach that there is no direct relationship between cost and value.  Otherwise a rock extracted from a diamond mine and a diamond extracted from the same mine would have the same value, because the cost of extracting them was exactly the same.  An 8 x 10” oil painting by Joe Schwartz and an 8 x 10” oil painting by Vincent Van Gogh would have exactly the same value because the cost of materials (the paint and canvas) were exactly the same.

Plainly “time and materials” do not equal value.  And in a marketing world where the cost of some media (You Tube) is zero, and the time required to execute an idea (AdWords) is sometimes close to zero, agencies are now forced to find other ways to be compensated than counting up their costs.  Sooner rather than later, all agencies will have to learn “price-led costing” and abandon the flawed model of “cost-led pricing.”